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Wednesday, September 4, 2013

Brazil's Volatile Real: Why Currency Fluctuations are Painful

Brazil’s volatile currency, the real, is back in the news. Two years
ago, the real hit all-time highs against the dollar. The rise prompted
Brazil’s finance minister, Guido Mantega, to accuse the central banks of
advanced countries, the Fed in particular, of conducting a “currency war”
at his country’s expense. Now the real is heading back toward the lows
it reached in 2008, at the depth of the global financial crisis. One
might think that if a strong real is bad, then a weak real must be good,
but that has not been the reaction. Instead, the recent depreciation
has caused Brazil’s central bank president to complain about the “adverse winds” from a strong dollar.

Why
are currency fluctuations, regardless of direction, so painful, and not
just for Brazil? The traditional notion is that exchange rate
movements, whether appreciation or depreciation, produce roughly equal
gains and losses. Some of them come from the effects on trade in goods
and services. When a country’s currency appreciates, its exporters find
it harder to sell their products abroad and domestic producers have a
harder time competing with imports. They are losers. Meanwhile, firms
that use imported inputs and consumers of imported goods are winners.
There are also financial effects. People whose foreign currency assets
exceed their foreign currency liabilities gain from appreciation of the
domestic currency, and those with foreign currency liabilities greater
than foreign currency assets lose.>>>Read more

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